Free is not a business model

Free is not a business model

Summary: Chris Anderson, author of the new book about giving stuff away free on the Internet, says that freemium is now the main business model of the SaaS industry. I'm not so sure, but I do think some applications will end up free at the point of use.

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The usual blast of hot air is wafting around the Internet in a renewed discussion of how to make money from giving content and services away for free. This has been prompted by the publication of Wired editor Chris Anderson's new book, Free: The Future of a Radical Price. A lot of people seem to like the idea of being able to make money without having to charge for what they do, presumably because the idea of asking people for money makes them uncomfortable, or because they haven't the vaguest notion of how to go about building a charging mechanism into their website (vide Twitter, Facebook, etc).

The unfortunate side-effect of this kind of wishful thinking is that otherwise sensible people write utter tosh about this topic. I've just read a blog post by Mark Cuban, in which he asserts that Google "lives and dies by free." I don't think so. Maybe Cuban is privy to a Google scheme that I'm not aware of, but I've not heard of Google giving away advertising, unless you count the $50 introductory vouchers it uses to get people hooked on AdWords. Google's business model is selling ads, and it has so little effective competition that it gets away with charging a fat premium for those ads. Sure, those ads run on content that's free at the point of use, but none of that content is owned by Google. Google's genius is to have built a business that allows it to make money by piggy-backing on other people's free content. The rest of the Web absorbs the risk, Google gets the profit. Nice one, guys.

Not even Anderson believes that people can make money without charging someone for something. In a revealing blog debate hosted by John Gapper of the Financial Times, he spells out that his book is not about free so much as freemium — the notion of giving away some things for free as a means of luring potential paying customers. In a statement that will intrigue the many readers of this blog from the SaaS industry, Anderson elaborates:

"... this is actually the core of the book. When I refer to a 'new economic model', I'm not referring to slapping advertising against stuff, which dates back centuries. Instead, I'm talking about the underlying economics that allow Freemium to work. Freemium is the inversion of the traditional free sample. Rather than giving out few percent of your product away for free as marketing, hoping to sell the rest, you give away most of your product for free as marketing, hoping to sell to a minority. This is only possible in the online realm, where the marginal costs of production and distribution are close enough to zero to 'round down'.

"Freemium is now the main business model of the booming 'software as a service' industry online, the online games industry and the fast-growing iPhone applications market. I think that creating business models around Freemium — what to charge for and what not to, a question determined as much by psychology as economics — will be the most interesting, and lucrative, efforts of this online era. And the book, both in its chapters and its tactical advice at the back, is intended to help guide that."

Anderson clearly understands this model all too well, for you can read the debate for free in John Gapper's blog, in blog posts by VCs Fred Wilson and Brad Feld, and in a critical book review by Malcolm Gladwell in the New Yorker. But if you want to settle down in your snug to read the hardcover book itself, it'll set you back up to $27 (currently Amazon is offering a third off that price). Though UK readers prepared to compromise with alternatives can get a special sponsored abridged version or an audio book version for free.

I suspect most practitioners in the SaaS industry will be surprised to learn that freemium is now their main business model, as Anderson asserts. That may be true for productivity software vendors — Zoho, Google Apps and Adobe all practice a freemium model — but I'd find it hard to identify any freemium in the business models of leading SaaS application vendors such as Salesforce.com, NetSuite and SuccessFactors. Freemium won't work for everyone. But there are a couple of important trends described in Anderson's book that we should all be conscious of.

  1. The cost of distributing content and software online has fallen close to zero. This is highly disruptive for companies whose business model was designed for a prior era when distribution was more costly, such as print media, entertainment and software publishing. Software with mass market appeal — so long as it's easy to develop, operate, support and maintain — now costs virtually nothing to deliver to customers, which means the high prices and comfortable margins vendors used to charge are now being wiped out.
  2. Certain classes of software, delivered as SaaS, will become free at the point of use. The virtual elimination of distribution costs will allow new vendors to enter markets with business models that rely on one or more of three alternative revenue sources to cover the cost of their free offering. The most disruptive of these competitors will be the ones that identify alternative revenue sources with high value and/or high margins, because this substitute revenue will fund low-to-free software pricing in markets where conventional vendors have traditionally charged high prices.

The three alternative revenue sources are:

  • Advertising. As we've seen from Google Apps, non-intrusive advertising does seem to be accepted even for business use when it's perceived as funding free use of the application. SaaS vendors should be cautious, however, as we have no confirmed evidence even that Google (let alone anyone else offering ad-funded apps) makes enough from advertising to cover its costs.
  • Freemium. Distributing a free version in order to reach a wider market, among which some customers will decide to pay for premium services, is well established. It's worked for some open source vendors and for SaaS vendors with mass-market appeal as 37signals and Box.net. As I've discussed previously, the trick is to target the right free users to yield a sufficiently lucrative conversion rate. I don't agree with Anderson that this is the default business model for SaaS, but I do agree that we haven't yet explored all the potential it holds.
  • Syndication. I'm not sure about the name — it may end up being called something else — it's the least developed of the three, but I think it holds the greatest potential. What I mean by syndication is delivering third-party services within an application and taking a commission on the sale. I've previously called it promotion, as opposed to advertising — it's also akin to what the retail industry calls merchandising. Some examples include SlideRocket, which sells media objects, such as images, music and cartoons, for use in slideshows created on its platform, or SmartRecruiters.com, which is a free online recruitment application for small businesses, funded by reselling a portfolio of ancillary services within the application, such as job board placements and reference checking. I recently recorded a podcast with the vendor's CEO about this model. Last month, at the OnDemand Europe conference in Amsterdam, he took part in a very interesting panel discussion I moderated on the topic of SaaS monetization. A video of that discussion is now online.

I believe we're at an interesting juncture, when new models are being tested out that will be game-changing for certain applications. But no one should be under any illusions here. The rules of arithmetic have not been subverted. Giving away stuff for free is not a business model, it's either an act of benevolence or it's a marketing ploy. If it's the latter, then you'd better make sure you've planned a sustainable means of making money once your marketing starts to bring in customers — either that or find yourself some extremely benevolent financial backers (if you believe such a thing exists).

Topics: Emerging Tech, CXO, Cloud, Data Centers, Google

Phil Wainewright

About Phil Wainewright

Since 1998, Phil Wainewright has been a thought leader in cloud computing as a blogger, analyst and consultant.

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74 comments
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  • Putting mium in free-mium

    Hi Phil,

    Excellent post. I share your shock about people's mis-characterization of the importance of "free," particularly in SaaS business models.

    One minor comment on freemium models. As I talk to "Web 3.0" (as you call it) entrepreneurs, I realize that the issue isn't that they haven't thought of the possible revenue streams (freemium, advertising, subscription, etc.) The challenge is that many haven't put in the hard analysis to figure out which model would logically get the company to profitability and how - e.g.,:
    * What is the up-sell from free that freemium clients will pay for? What would people pay in the premium service? What would your upsell rate be?
    * What is the demographic or other targeting that would cause advertisers to pay a premium for what you do? How much would it be?

    These questions are impossible to answer in advance but they are still critical to ponder because they help you model scenarios (e.g., if we only are going to get a $0.10 CPM on our traffic, we'd better be pretty huge!)

    Nick
    nrmehta
  • Businesses prividing free service are based on HOPE!

    Such hope based business models must be categorized as
    social entrepreneurship. Thanks for so many VCs committing their money to such businesses. These
    investors are directly contributing to some kind of
    social service.

    http://twitter.com/thyaga
    ThyagaV
    • You're correct (in a strange way)

      When one looks at the power of twitter by the Iranian opposition, one wonders whether a service like this is significant enough to receive a grant by the government as a strategic service akin to the first communication cables laid between different continents. It is services like twitter that will undermine and mobilise the masses in totalitarian regimes as the decrepit apparatus of the state struggles to keep up.
      Macintoshtoffy
      • I don't use Twitter. I am not a corporation or a corp. interest.

        Only folks that want to advertize (for free) are on Twitter. I don't Tweet! I only fart! EOS!
        No More Microsoft Software Ever!
  • In the land of the blind...

    Phil, this is by far one of the best posts in the increasingly hysterical debate over free.

    I'll just add a couple of points: one of the side effects of using free to gain market share without having a sound monetization model is than you end up not just damaging yourself - but also your competitors. It's hard to compete with free. I call this 'Kamikaze Marketing'.

    Secondly, I believe the prevalence of businesses using freemium reflects less on the benefits of freemium, and more on the lack of viable alternatives. In other words, in the land of blind revenue models, one-eyed freemium is currently king.

    I think that rather than bashing free, people should focus their efforts on filling this void. For example, bringing cloud style usage billing to the end user seems like a good place to start.
    DSemeria
    • Hard to compete

      It is hard to compete with free.

      I have a piece of shareware that I paid about $39 for, eight years ago. There was a free version, and a couple of stepped up versions that added features.

      Periodic updates were free, and response time to bugs was very quick.

      Then a clearly competitive product came out "for free". I thought it might be a one time release, with no updates, but it was updated over time, and seemed to be a decent program.

      I feel bad for the guy trying to make a decent living, trying to compete against someone who didn't need the money, for whatever reason.

      No advertising, no apparent support from a benevolent parent company or even hosting service, just no need for money. Maybe this guy retired from the software biz, and considers this package to be a hobby.

      Free is not a sustainable business model. The money has to come from somewhere.
      ClarenceD
      • Very true

        Unless you have something unique that is really hard for someone else to provide, you are very vulnerable. And you are at the mercy of your stupidest competitor. They may go down, but they can take you with them.

        How many of these "free" services actually make money? Even most of the Google ones are losing it hand over fist, paid for by the ads they get in the Search space. Everything else is a loser.

        I think Freemium is a myth. We all had the promises of "First get the eyeballs, then convert them to paying customers." We called it the .com bubble, and here it comes again.
        A.Sinic
        • Vulnerable to free = bad business model

          Somebody makes the comment about "kamikaze competition" where a free supplier ruins the market for everybody else. This is where most people miss the disruptive power of internet distribution. Here's the scoop: if you are in a business where you can be threatened by somebody giving away their software or services for free, then LOOK SOMEPLACE ELSE. The market you are in is gone, never to return.

          I know many people don't want to hear this, but you will either learn the lesson proactivley, or be taught it the hard way when the market kills you off.
          terry flores
      • I don't agree

        I'm on a Mac and looking forward to a new release of Blogo - sure, I could use the free posting form provided by blogger to submit posts, I could possibly use one of the many freeware clients out there - but I need something that properly supports all the features of blogger.

        The reason why I haven't purchased Blogo yet, not because it competes with free but because the HTML support isn't up to scratch.

        You can compete with free when you product is significantly better than free - when your product is 'paid for', you can afford to have people who know what they're doing when it comes to interface design - compare that to the opensource and freeware world of volunteers where there are talented programmers but UI is secondary in the triage.

        It is up to you to make the case for why people should buy your software rather than holding a defeatist attitude of "its all too hard" and "I can't compete with free".
        Macintoshtoffy
        • I have to agree. So much 'IT Tech' can be accomplished by newbies!

          Face it. Folks with only 1 year of computing experience can build a computer, website, on-line survey, etc.

          Fact is that tech is moving faster than Microsoft would like. Microsoft would like folks to use MS warez instead of hand coding.

          Microsoft is about to lose. Apple, on the other hand, still has their glorious hardware to make them money. Hardware is becoming KEY. Software is the part that is becoming a commodity. Long Live the Dead! Long Live Microsoft!
          No More Microsoft Software Ever!
      • money needs are subjective, & comparisons

        hmm...several thoughts -
        1st, how do we really know that the guy charging for software is just trying to make a decent living? he might be a price gouger and materialistic SOB, or he might be a philanthropist with the goal of donating his money later. we dont know, and it is wrong to put your own assumptions on his motives for charging for his software.

        2nd, if someone does NOT need money and does NOT want to charge, then that just shows that he maybe doesnt need nor want so much money. i can empathize with him, i dont want a ton of money either, i WANT to live in a studio apartment with few possessions, i dont need much, and im quite happy. i dont want more JUNK clogging up my life, so why should we fault someone else just because he may not be materialistic? or, for all we know, he may even be a religious pious minister who wants to help others, or a raving red socialist who thinks that everything should be shared in society for the most efficiency. or something else?

        free is very difficult to compete with.
        free is usually not sustainable, but can you stay in business charging $ when a competitor is offering free?
        where else have we seen this before???

        look at highways versus mass transport such as railroads and airlines....
        how can a private railroad company offer money-losing passenger services yet pay for all their land, their own signaling system, their own dispatchers, and their own equipement and vehicles? AND pay taxes on ALL OF IT? (they couldnt, hence all the disappearance of private trains and the creation of government-owned amtrak). compare to other companies such as airlines who just have to obtain equipment and vehicles but get to use government-provided and tax-exempt airport lands and air traffic control. and even they are going bankrupt as we speak.

        but neither can do well when pratically the entire free road system is laid side-by-side between the same city pairs that railroads and airlines serve. an 18 cents per gallon federal gas tax that has remained the same almost TWO DECADES is not sufficient "charging" to automobilists. people think it is faster, easier, cheaper, etc to drive places, and so far they are right, because the roads are not owned nor even rented by each individual driver, and there are rarely tolls (and when they do exist or are added, they are unpopular). even though greyhound and other buses get free use of the roads, they do not share in the passenger loads, leading to huge cutbacks in bus network too.
        when automobiles still get about 90% of all intercity travel, and airlines are around 8%, and greyhound has less than 2%, and amtrak has less than 2% -- this helps to show how difficult it is to compete with FREE. and it is even worse when it is your own government providing the FREE service with unlimited pockets and no financiers or bankers to reign it in.

        it is not to say that companies cant exist, but it is extremely hard, and leads to less other choices. hence why there are few airlines and bus companies, and reduced to one main passenger rail.

        so, to everyone who disagrees with free software, write letters to your states and congresmen demanding toll transponders to be added to every interstate, expressway for the premium speed and safety, and traffic lights for the electricity costs, and start charging for highway police services instead of giving it away, and that way drivers will start paying the true costs of the roads and stop hiding these costs thru property tax subsidies.

        if software can not be free, then neither should a premium hghway like an interstate. if you provide free interstates and expressways, then provide free amtrak and free greyhound, and free city transit too.
        rivardau
        • Bottled water:

          >free is very difficult to compete with.
          >free is usually not sustainable, but can you >stay in business charging $ when a competitor >is offering free?
          >where else have we seen this before???

          Im sure I could come up with many more as well, but bottled water is a classic case of people paying money for something that is available for free.

          Why, they percieve the quality is better, to the point where they choose to pay hard earned money as opposed to getting it free from the tap.

          There are many products that come in very cheap to very expensive ranges, the very expensive products still sell, why because people WANT to buy that product.

          MS sells software because there are people willing to buy it, EVEN when there are free alternatives.

          Thats our freedom, the freedom of choice, the freedom to buy what I want, and can afford to do what I want.

          If you dont reward quality and invention with money, you will not get the quality you require.

          Programmers who are not paid for effort and who dont consider their product "saleable" then they have no interest in creating software that people are willing to pay for, in other words it not meet all the requirements that are necessary for that product to e uptaken.

          Quality
          Functionality
          Price
          Avalibility
          Reliability
          Stability of provider

          Price is one and a small part of the purchasing matrix of requirements need to be met for a successfull purchase or acquisitions.

          Nuff said.
          Aussie_Troll
      • Money does not need to come from software...

        "[i]Free is not a sustainable business model. The money has to come from somewhere.[/i]"

        I have to disagree, and so does everyone who can see what is actually happening, not just claims about it.

        There are currently quite a load of software producers (eg. several linux distributors) that do not make money *from* the software but rather from services *for* the software, selling ads, etc.
        There are many ways for software producers to make money without it coming from software itself - unless you count servicers for software, etc. to provide money from software, which is not how the things are defined in the original post - and these are facts that we can see around us, not just mere claims.
        robsku
    • Fact is...it's about FREEDOM for the USER not the Corporation!

      Time for a FREENET to take over and give users and consumers the VOICE they need. This is NOT about giving companies and Corporations access to buyers. It's about buyers saying Hell No! or Give Us This! or Give Us THAT!

      Time for folks to realize the 'Net is about US and not about THOSE or THEM!
      No More Microsoft Software Ever!
  • This was a very poorly considered post.

    You totally, completely, utterly miss the point. Or, you're just trying to make something to write about.

    Nobody believes you can make money by not charging for anything.

    Google certainly does live and die by free. The only reason Google can sell ads is that they draw people to look at the ads - through FREE services like search, gmail, etc.

    Free is a business model and a darned good one at that.

    This was a very poorly considered post.
    theotherjdub
  • RE: Free is not a business model

    This is a really interesting write up of what looks like an interesting book.

    I am CEO of a social network for small businesses and we have, in one way or another, tried all three models.

    We started with advertising on a free service, which tied us over until we gout our premium offering launched, which is contributing revenues. But if you look at other social networks, the banner waver for the freemium model is XING of Germany, which converts "only" 8% of its members into paid subscribers. Great if you have 7 million members, but harder to live on with a much smaller community (we launched our premium option only 5 months ago).

    We'll soon be adding what you're terming a syndication option of sorts, by adding Social CRM capabilities to our site. Likely to be of great interested to our power users, it's an option which we'll be charging four times current levels to gain access to, but the value of that offering will be more obvious to people: you expect to pay for CRM, you don't necessarily expect to pay for social networks, even if they bring you sales leads.

    I'll come back and report how this part of the plan goes!

    Ian Hendry
    CEO, WeCanDo.BIZ
    http://www.wecando.biz
    ianhendry
  • RE: Free is not a business model

    Phil,you are close enough to the business to know that this is just not true:

    "The cost of distributing content and software online has fallen close to zero."

    I've been in plenty of budget meetings in ExactTarget, Compendium Blogware and seen the costs in the publicly traded SaaS companies to know that Capital Expenditures is a big chunk of the costs.


    chris@...
  • RE: Free is not a business model

    Not all economic value added comes from "business models". Consider free public roads, free clean air, etc. There are businesses there, and payment models; they are just not "business models" in the conventional sense. Instead they include elements of institutional subsidy, public subsidy, taxation, fees on the production system to recover the costs of externalities, user fees via, for example, the gasoline tax, etc. Some sectors subsidize other sectors as, for example, with rural cell phone service or telephone services for the deaf.

    Come to that, the intenet itself began as "free" though it was, in fact, subsidized by the government--i.e. the general taxpayer.

    Not everything has to be a "business model" to produce massive value added for the economy and society. To think that way is to turn a mixed economy on its head and return to the worst days of unregulated capitalism and monopoly exploitation.
    david@...
  • There is free and there is "free"

    Trying to characterize everything with a "business model" is a futile attempt. Just look at the current financial crisis as the result of mischaracterizing the financial market with models. Espacially the latest "rational" model.

    Nothing is absolutely free. However, you get to decide who gets the "free" portion of the service, and who pays for the support.

    Social networks and free e-mail are two perfect examples of "free" services to the consumers, but that are loaded with paid advertising. So, companies rip the benefit of the advertising, and consumers rip the benefit of using the service.

    As for Operating Systems, I can get a free download of a distribution of Linux, but I will pay the price of doing research to set it up properly and support it. Or I can pay a company to do that for me. So, there is another example of companies riping the benefit of supporting a "free" service.

    Want to create a "business model" around it to make it official? Go ahead, but it is not really going to change the way it works.
    fernande-zdnet
    • free as in beer

      free as in beer vs free speech.
      magallanes